The Obligations of Adjustment

The Mt. Washington Hotel in Bretton Woods, New Hampshire, site of the Bretton Woods conference which established the IMF and World Bank. (Shutterstock)

Previous posts discussed the seemingly intractable challenge of getting an agreement on IMF governance reform and the relationship between the IMF and the G20 (here and here). The difficulties encountered in securing a consensus on IMF governance reform, it was argued, can be traced to the essential zero-sum game nature of quota reform. To facilitate agreement, it is necessary to embed the quota issue in a broader, positive-sum game.

Success in that broader game will require a clear-headed assessment of the responsibilities and obligations that members have to each other and the system in the early decades of the 21st century. Those responsibilities and obligations will, of course, depend on the nature of the challenges that lie ahead.

What are these challenges?

In some respects, they mirror the adjustment challenges of the early Bretton Woods years. Many advanced economies have public debt burdens at levels not seen since the 1950s. In a number of countries, priority has been placed on fiscal adjustment either because of loss (or the threat of loss) of market access, concious policy choice or political gridlock. In most of these countries, unemployment remains too high and output has not returned to potential. This has placed the full burden for stabilization policy on central banks, which owing to the zero-lower-bound problem of nominal interest rates having been pushed as low as they can go, have reverted to extraordinary measures of quantitative easing.

These measures are appropriate in the domestic circumstances in which they have been mobilized. And, yet, they have external effects as liquidity spills over national financial systems in search of yield, leading to exchange rate depreciation and concerns of a currency war and beggar-thy-neighbour exchange rate depreciation reminiscent of the inter-war period in the last century.

In other regards, however, the comparison with the early years of the Bretton Woods period fails. A key challenge then was to rebuild the capital stocks of war-ravaged economies in Europe and Asia, many of which confronted extremely-high unemployment rates and the threat of economic collapse. In North America, the challenge was to sustain full employment in the face of demobilization of men and women in the armed forces and the demilitarization of the economy from its wartime production mode.

At the same time, there are important structural differences between the current conjuncture and the early Bretton Woods era. Progressive trade liberalization over the past six decades has created a dynamic international trading system that by no means meets the trade economist's ideal of free trade, but which has promoted a remarkable degree of global division of labour and is a source of prosperity for millions. In contrast, in the early days of the Bretton Woods system, the global trading system was blocked up by high tariff levels erected in the depression years and by a dysfunctional international payments system marked by currencies that were inconvertible for settling trade flows.

In addition, for the most part, the Bretton Woods system was supported by national financial systems that were fragmented and separated by the widespread use of capital controls and financial regulations designed, in the words of Keynes, to "keep finance national." The prevailing view was that globally-integrated financial markets helped transmit financial shocks and propagated stagnation in the Great Depression. Moreover, capital controls were needed to reconcile the policy objective of full employment with the management of exchange rates. In comparison, financial markets today are highly-integrated (though, perhaps, somewhat less so as a result of "prudential" capital controls used to limit the effects of liquidity spillovers from extraordinary monetary measures adopted by some advanced country central banks). And the policy trilemma has been resolved, for the most part, by the adoption of flexible exchange rate regimes.

There is, as well, a longer-term challenge that the architects of the Bretton Woods system did not have to worry about. In the advanced economies, demographic changes pose serious economic and fiscal challenges, as the ratio of working age to general population falls and the pension and health care costs associated with the ageing of the post-war baby boom rise. Emerging economies, in contrast, have rapidly growing young populations and a need for infrastructure and other investment to provide their populations with rising income levels. There is a potential gain from trade here —albeit intertemporal trade — as advanced economy savings are invested in productive projects in emerging economies.

These are the challenges. The next post will attempt an initial identification of the obligations and responsibilities that members of the international community face in the New Age of Uncertainty.

The opinions expressed in this article/multimedia are those of the author(s) and do not necessarily reflect the views of CIGI or its Board of Directors.

James A. Haley has been a CIGI senior fellow since September 2014. He is currently public policy fellow at the Woodrow Wilson International Center for Scholars in Washington, DC.

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